Stablecoin wars: The battle for stablecoin supremacy is heating up. Binance, the world’s largest crypto exchange by daily trading volume, escalated its assault on the second-largest stablecoin, USDC — removing support for Circle’s product from the exchange altogether.
Earlier this month on September 9, Binance announced that it would automatically convert all investments in USDC, Pax Dollar (USDP) and TrueUSD (TUSD) into its native stablecoin Binance USD (BUSD) on September 29.
Prominent Indian exchange WazirX also moved in support of Binance, choosing to delist the aforementioned assets in favour of BUSD.
According to a research report from the Bank of America, the automatic conversion could see the supply of BUSD increase by as much as $908 million, as 2% (US$898 million) of USDC’s supply and 1% (US$10 million) of USDP’s supply are currently held on Binance.
At the time of writing Tether (USDT) leads the stablecoin race with a US$68 billion market capitalization accounting for a little more than 40% of the entire stablecoin economy. Circle’s USDC sits in third place at US$50 billion, while BUSD hangs back in third with a healthy value of US$20 billion.
Why do stablecoins matter so much?
Put simply, stablecoins are the overarching suppliers of liquidity (the flow of money) in the crypto economy. As a result they have an enormous amount of direct and indirect control over the day-to-day activities of the crypto market.
As the worlds of traditional and digital finance continue to become increasingly correlated, an unregulated stablecoin with shady accounting practices & questionable reserves — something that Tether has been accused of — could lead to disastrous flow-on contagion issues.
Secondly, due to the fact that they directly control how and when investors cash in and out of the crypto economy, whatever course of action a major stablecoin provider chooses to support — or reject — essentially forces an unofficial, financial consensus upon a captive cryptosphere.
At the beginning of August, Ethereum co-founder Vitalik Buterin spoke with Near Protocol founder Illia Polosukhin at the BUIDL Asia conference in Seoul and provided some unique insight into the significant amount of sway that stablecoins hold over the crypto industry.
Stablecoin wars and hard forks
Vitalik’s most potent concern for stablecoins arises in the context of a “hard fork”, with Vitalik expressing some concern centralised stablecoins could be “significant” deciders of which blockchain protocol the industry would “respect” in future forks.
A hard fork occurs when there is a radical change to the protocol of a blockchain network that effectively results in two versions such as Ethereum and Ethereum Classic (ETC). Typically, one chain ends up being preferred over another:
“At the moment of The Merge, you will have two separate networks, and then you have exchanges, you have Oracle providers, you have stablecoin providers that are kind of deciding in a way, which one they respect.”
“Because at that point, you’ll have 100 billion of USDT on one chain and 100 billion of USDT on the other chain, cryptographically — and so, they [Tether] need to stop respecting one of them,” explained Buterin.
Obviously, the Merge went through without a hitch and no substantial stablecoin providers showed any real support for the recently hard forked ETHW chain that was pioneered by Ethereum miner and Proof-of-Work purist, Chandler Guo.
Stablecoin centralisation
At the time however, Vitalik was more concerned about the long-term future of stablecoin centralisation.
“I think in the further future, that definitely becomes more of a concern. Basically, the fact that USDC or USDT’s decision of which chain to consider as Ethereum could become a significant decider in future contentious hard forks.”
He added that in the next five to ten years, Ethereum may see more contentious hard forks where centralised stablecoin providers could carry more weight.
“At that point, maybe the Ethereum foundation will be weaker, maybe the ETH 2 client teams will have more power, and maybe someone like Coinbase, would both run a stablecoin and have bought up one of the client teams by then…like lots of those kinds of things could happen,” he said.
Offering up a potential antidote to what he sees as worrying trend towards centralised actors, Vitalik proposed opting for different kinds of stablecoins:
“The best answer I can come up with is to encourage the adoption of more kinds of stablecoins. Basically, you know, people could use USDC, but then they could also use DAI and like, at this point, I mean, like DAI has taken this kind of very decisive route of saying ‘we’re not going to be purely crypto economic we’re going to be a wrapper for a whole bunch of real world assets’”.
Stablecoins pose unique risks
As we’ve learned from the mayhem that followed the Terra (LUNA) crisis — where the arbitrage-powered algorithmic stablecoin ‘UST’ collapsed to near-zero in a matter of hours — stablecoins can pose significant risks to both crypto and traditional finance.
The fallout from the Terra crisis collected the scalps of multiple major firms in the crypto space, as companies like Three Arrows Capital and Voyager Digital became rapidly embroiled in a “domino-effect” style liquidity contagion that swept through the market.
While the more risk-averse firms and exchanges in the industry survived without incident due to “proper treasury management”, the roughly $100 billion dollar fallout saw regulators become far more attentive to the unregulated nature of stablecoins.
Regulation
The Federal Reserve’s Vice Chair, Lael Brainard noted these flow-on risks while speaking at the Clearing House and Bank Policy Institute 2022 annual conference earlier this month.
“Stablecoins are one of those areas that I think have the most potential for risk if not properly regulated and of course those risks can easily spill into the main core financial system because of the runnable nature of stablecoins,” she said.
Brainard added that while the crypto market carries similar risks to that of traditional finance, tailored regulatory solutions are needed if the industry wants to be sustainable in the long run.
“We have seen that the crypto financial system has all the same risks that we’re very familiar with from traditional finance,” she said.
However, because of the fast-paced nature of cryptocurrencies, there needs to be special
attention paid to “creating clear regulatory guardrails”.
Framework
Today, Brainard’s advice was heeded as draft legislation to create a U.S. federal framework around stablecoins officially hit the floor of Congress.
According to The Block, if passed, the new bill will temporarily ban stablecoins that are not backed by external assets. Nonbank issuers of stablecoins backed by fiat currency would also be overseen by state banking regulators and the Federal Reserve.
American Banks and credit unions will remain free to issue their own stablecoins, but would be overseen by the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation, both of which serve as federal bank regulators in the US.
Issuing a stablecoin without approval from those regulators could be punishable by up to five years in prison and a US$1 million fine.
The state of Aussie stablecoins
Back home in Australia, stablecoins and their implications are also beginning to feel some wind in their sails. On June 1st, ANZ bank executive Nigel Dobson told The Australian Financial Review Banking Summit that its Australian Dollar-pegged A$DC stablecoin will be extended into the retail investing sector, allowing everyday investors to buy a broad range of digital assets with Australian dollars.
Obviously, ANZ doubling down on their A$DC product comes during a tumultuous time for crypto markets, which has seen a significant volume of capital leave space over the past few months.
On Monday, Liberal Senator Andrew Bragg drafted a new bill that would offer some clarity for regulating stablecoins in Australia.
If Bragg’s bill passes, it would become an offence to issue a stablecoin without a licence. Additionally the bill includes requirements for stablecoins backed by Australian or foreign currency to be held in reserve in an Australian bank, so that it can be audited quarterly by APRA.
Bragg’s bill
Bragg’s bill would apply directly to ANZ’s A$DC, but wouldn’t pose much of an issue as ANZ is a major financial institution. Instead Bragg’s bill would seek to make it far more difficult for a private firm, like Do-Kwon’s Terralabs, to unleash a potentially ‘not-so-stable’ stablecoin into the already volatile world of financial assets.
Ultimately, as stablecoins become more frequently used throughout the crypto economy, and with countries seeking to gain access to digital assets in their own domestic currency, practical regulation is a welcome addition to the space.
While regulation can definitely work to reduce the potential volatility that comes with private firms issuing their own bootleg stablecoins, the problem of centralisation remains ever present. At the end of the day, whoever the dominant stablecoin provider is, can use their liquidity as a majorly centralised vote to control the flow of activity in the crypto ecosystem.
